Define net present value and the decision rule.

Define net present value and the decision rule.

• A. NPV is the present value of inflows minus outflows; accept if NPV > 0.
• B. NPV is the sum of inflows minus outflows without discounting; accept if positive.
• C. NPV is the final cash balance at project's end.
• D. NPV is the ratio of inflows to outflows.

Answer: (A)

Net present value looks at how much value an investment creates by discounting future cash inflows back to today and subtracting the cash outflows. Because money now is worth more than money later, we compare the present value of inflows to the present value of outflows. The rule is to proceed with the project if NPV is positive, since that means the investment earns more than the required return and adds value to the firm. If NPV is negative, it would destroy value, and if NPV is zero, you’re indifferent. This aligns with the choice that defines NPV as the present value of inflows minus outflows and uses a positive threshold to accept. The other statements fail because they ignore the time value of money, or they look at only a final cash balance, or they use a ratio instead of a net present value measure.

Net present value looks at how much value an investment creates by discounting future cash inflows back to today and subtracting the cash outflows. Because money now is worth more than money later, we compare the present value of inflows to the present value of outflows. The rule is to proceed with the project if NPV is positive, since that means the investment earns more than the required return and adds value to the firm. If NPV is negative, it would destroy value, and if NPV is zero, you’re indifferent.

This aligns with the choice that defines NPV as the present value of inflows minus outflows and uses a positive threshold to accept. The other statements fail because they ignore the time value of money, or they look at only a final cash balance, or they use a ratio instead of a net present value measure.